Good morning. My name is Jael, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website at www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer period, and instructions will follow at that time. I will now turn the conference over to your host, Sean Rourke.
Thanks, Jael, and good morning, everyone. Welcome to Virtus Investment Partners' discussion of our third quarter 2026 financial and operating results. Joining me today are George Aylward, our President and CEO, and Mike Angerthal, our Chief Financial Officer. After the prepared remarks, we will open the call for questions. Before we begin, I'll refer you to the discussions on slide two. Today's comments may include forward-looking statements, which involve risks and uncertainties described in our news release and SEC filings. Actual results may differ materially. We will also reference certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are available in today's news release and financial supplement on our website. Now I'd like to turn the call over to George. George?
Thank you, Sean, and good morning, everyone. Before we start, I'd like to thank you for your patience with the timing of our release this quarter, which was rescheduled to allow additional time to complete our quarterly review processes. I'll begin with an overview of the results, and then Mike will provide more detail. Our third quarter results continue to reflect the impact of the challenges in our quality-oriented equity strategies, which accounted for substantially all of the net outflows. Our other strategies, now in more than two-thirds of our assets, were relatively stable. Net outflows, along with negative market performance, resulted in a 7% decrease in assets under management. As we have previously commented, for an extended period, market returns have been led by a narrow group of momentum-driven and AI-related stocks, which was a difficult backdrop for quality investing.
Since late in the second quarter, we have seen periods of momentum leadership fading and weakness in AI, and as a result, several of our quality strategies have been generating strong relative performance. Though we recognize that a single quarter does not offset the longer-term performance challenges, these more recent results are encouraging, and some of our quality strategies have now moved into the top half of their peer groups for the trailing 12-month period. Our quality managers have remained disciplined, and our confidence in their approach is unchanged. Against that backdrop, highlights for the quarter included continued positive net flows in ETFs, where AUM has grown 24% over the past year, the issuance of a new CLO and the launch of three actively managed ETFs, a higher operating margin and earnings per share, continued return of capital, including our ninth annual dividend increase, and a reduction in debt.
While the environment for quality equity has been a headwind and created challenges, this also resulted in our now having a meaningfully more diversified set of offerings. Quality-oriented strategies represent 31% of our assets, down from 45% a year ago, while fixed income, multi-asset, alternatives, and equity strategies without a quality orientation represent 69%, with fixed income and alternatives each generating positive net flows over that period. That broader mix of across asset classes and strategies should make our earnings more resilient through different market environments. We continue to actively focus on diversifying our sources of growth, primarily with ETFs, alternatives, fixed income, and wealth management. ETFs have delivered a 27% organic growth rate over the past year, and we now have active ETFs across the majority of our capabilities, with several more expected to launch over the next few quarters.
In alternatives, we have significantly broadened our capabilities with the addition of private market strategies, and alternatives now represent 14% of our AUM. In fixed income, we continue to create new products in various wrappers and are seeing consistent positive flows. In our $9 billion wealth management business, we are expanding our business development resources. We will continue to invest where we see attractive long-term opportunities. Looking at our third quarter results, assets under management were $141 billion at September 30th, down from $152 billion, reflecting market performance and net outflows. Total sales were $4.3 billion compared with $6.1 billion last quarter, with lower sales across products. In addition to a large institutional listed real estate win last quarter, the decline was driven by quality-oriented equity strategies. Net outflows were $6.1 billion compared with $5.6 billion, with substantially all of the net outflows in the quality-oriented equity strategies.
Net outflows in our retail products improved for the second consecutive quarter as redemptions declined in both open-end funds and retail separate accounts. This was more than offset by higher institutional net outflows. On a product basis, we had positive net flows in ETFs and tender offer funds. In terms of what we saw in October, U.S. retail fund and ETF net flows declined modestly from the third quarter monthly average, reflecting higher redemptions while retail fund sales remained relatively consistent. Retail separate account net flows improved from the third quarter monthly average, particularly in wealth management, which had a strong month. On the institutional side, as we previously reported, we were notified late in the quarter of a $7 billion redemption in a quality-oriented equity strategy, which transitioned in mid-October.
That mandate had a fee rate of less than half of our overall average fee rate, so the revenue impact will be considerably less than the impact on assets under management. Excluding that mandate, known institutional redemptions modestly exceed known wins. In addition, for the month of October, our equity investment performance was a positive 1.5%, primarily due to strong performance from our quality equity strategies. That compares favorably with the broader market, as the S&P was down nearly 1% and the NASDAQ down over 5%. Turning now to our financial results, the operating margin was 28.7% compared with 26.1% last quarter, which included a discrete employment expense item. Excluding that item, the margin improved by 50 basis points. Earnings per share adjusted increased to $5.86 from $5.54.
In terms of our balance sheet and capital, we ended the quarter with meaningful liquidity, including cash and equivalents of $187 million, seed, CLO, and other investments of $298 million, and $235 million of undrawn capacity on our revolving credit facility. We continue to have financial flexibility to balance our capital priorities of investing in the business, returning capital to shareholders, and maintaining appropriate leverage. With that, I will turn the call over to Mike to provide more detail on the results. Mike.
Thank you, George. Good to be with you all this morning. Starting with our results on slide seven, assets under management. Total assets under management were $141.4 billion at September 30th, down 7% sequentially. The decline reflected $6.1 billion of net outflows and $4.3 billion of negative market performance. Average assets were $149.5 billion, down 3% sequentially. Because assets declined through the quarter, ending AUM was about 5% below the third quarter average. By product, our assets are well-diversified. Institutional accounts represent 34% of AUM, U.S. retail funds 28%, and retail separate accounts, including wealth management, 22%. Closed-end and tender offer funds make up 9%, and ETFs and global funds the remaining 7%. In terms of investment performance, our fixed income and alternative strategies continue to perform well across time periods. In fixed income, 83%, 70%, and 72% of strategies beat their benchmarks over the three, five, and 10-year periods.
In alternatives, 68%, 73%, and 93% beat their benchmarks over the same periods. In equities, while longer-term results against benchmarks continue to reflect the challenges faced by our quality-oriented strategies, relative performance improved in the third quarter. 58% of equity assets ranked in the top half of their peer groups, up from 22% last quarter, and several of our quality-oriented strategies ranked in the top quartile, some in the top decile. So far in the fourth quarter, most of our quality-oriented equity strategies rank in the top decile. Turning to slide eight, asset flows. Total sales were $4.3 billion compared with $6.1 billion in the second quarter.
Reviewing by product, institutional sales of $1.1 billion compared with $2.2 billion in the second quarter, with the decline due to the impact of last quarter's $0.7 billion global listed real estate mandate, in addition to lower sales this quarter in quality equity strategies. Third quarter sales included $0.4 billion from the issuance of a new CLO. Retail separate account sales of $1 billion compared with $1.2 billion, with lower sales in both intermediary sold and wealth management. Open-end fund sales of $2.2 billion included $0.4 billion of ETF sales, compared with $2.6 billion in the second quarter. Total net outflows were $6.1 billion compared with $5.6 billion last quarter. By product, institutional net outflows of $2.2 billion compared with $0.7 billion last quarter, reflecting both lower sales and higher redemptions. Retail separate account net outflows of $2.6 billion improved from $3.1 billion on lower redemptions.
The outflows continue to be primarily due to intermediary sold quality-oriented equities. Open-end fund net outflows of $1.3 billion improved from $1.8 billion due to lower redemptions in U.S. retail and global funds. Retail fixed income funds generated $0.4 billion of positive net flows, led by bank loan strategies, and ETFs generated $0.2 billion of positive net flows. Turning to slide nine, investment management fees as adjusted were $161.9 million, down 2% due to lower average assets under management. The average fee rate was 43 basis points, essentially unchanged, as lower performance fees were offset by manager reassignments made on some of our funds in August. The reassignments moved assets from unaffiliated subadvisors to certain of our managers, which added 0.7 basis points to our average fee rate in the quarter. Excluding performance fees, the fee rate increased to 42.4 basis points from 41.9.
For modeling purposes, the third quarter fee rate is reasonable, and as always, the fee rate will vary with market levels, asset mix, and performance fees. Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $95.5 million declined 7% sequentially, reflecting the prior quarter impact of a discrete non-cash expense item, as well as lower variable incentive compensation. As a percentage of revenues, employment expenses were 52.8% and improved by 70 basis points on a normalized basis. For modeling purposes, a range of 54%-56% is a reasonable level for the fourth quarter, given lower average assets and revenue. As always, results will vary with flows and market performance.
Turning to slide 11, other operating expenses as adjusted of $31.8 million were essentially unchanged from the prior quarter, as modestly higher operating expenses were offset by the prior quarter impact of the annual equity grant to the board of directors. On a year-to-date basis, other operating expenses were flat with the prior year period. For the fourth quarter, we expect to be at the higher end of our $30 million-$32 million range. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $51.8 million increased from $47.9 million, primarily due to lower employment expenses. The operating margin as adjusted was 28.7%, up from 26.1% in the prior quarter. Excluding the second quarter discrete item, the operating margin improved by 50 basis points.
With respect to non-operating items, interest and dividend income of $4.2 million declined sequentially due to elevated CLO interest income in the prior quarter. Turning to income taxes, our effective tax rate for the third quarter was 14% and compared with 13.3% in the prior quarter. For modeling purposes, an effective tax rate of approximately 11% is reasonable, reflecting the impact of our amortization cash tax benefit on sequentially lower pre-tax earnings. Net income as adjusted of $5.86 per diluted share increased from $5.54, primarily due to higher operating income, partially offset by lower interest income. On a GAAP basis, results included $2.2 million of restructuring costs, primarily related to actions to better rationalize resources through the expanded use of our shared services.
This will have a modest favorable impact on the employment expense ratio going forward and has been included in the range cited. These costs are excluded from our results as adjusted. Slide 13 shows the trend of our capital, liquidity, and select balance sheet items. Cash and equivalents at September 30th were $187 million, up from the prior quarter due to cash earnings in excess of return of capital and repayment of debt. In addition, we had $298 million of other investments, including seed capital to support future growth opportunities. Return of capital to shareholders in the third quarter included the repurchase of 64,666 shares of common stock for $10 million. We also raised our quarterly common dividend by 2% to $2.45 per share.
Other uses of capital during the quarter included $28 million to sponsor the launch of the new CLO and $15 million to repay a portion of the amount drawn on our revolving credit facility. Gross debt at the end of the quarter was $411 million, down from $427 million at June 30th. Net debt was $224 million, or 0.9 times EBITDA. With that, let me turn the call back over to George. George?
Thank you, Mike. We'll now take your questions. Jael, would you open up the lines, please?
Thank you. If you have a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, simply press star one again. One moment, please, for your first question. Your first question comes from the line of Bill Katz of TD Cowen. Your line is open.
Hi, good morning. It's Bradley Hays for Bill Katz. Any insights or commentary around performance trends? You noted a bit earlier that some of your quality managers have moved into the top half, top quartile of the peer group, and highlighted fixed income and all. Maybe you could dig in a little more there.
Yeah, no, it's been an interesting period as we sort of highlighted the trends over the last year or two. We've highlighted on several calls the strength of momentum versus the quality subcategory where we have an overweight. But in the period from the late June going forward, there's been these pockets of periods, and they've been more pronounced in last month. And it has been very rewarding to see that some of those strategies, when the momentum-driven and AI stocks fall out of favor, sort of demonstrate the reason why that those strategies can be a good part of a well-diversified portfolio. So, it was quite dramatic in terms of why we highlighted some of the performance numbers of being in the top quartile or even top quintile.
But the longer-term numbers are what matter, so it has been good to see that some of the numbers on a peer-adjusted basis are moving into the top half. So again, our view is those strategies do have a place in a well-diversified portfolio for an individual. Our fixed income has had strong investment performance continuously for many years. We're actually, I think Mike highlighted that we have positive flows. Actually, we've had positive flows in alternatives and fixed income over the last one-year period. And obviously, it's been overshadowed by the quality equity, which is absolutely a reasonable thing. But the strength of the fixed income, and we're pleased to see it in various areas, including in some of the funds, ETFs in particular. We're very optimistic about the opportunity set.
As you may recall, we launched a number of fixed income ETFs years ago, and several of them have very good track records of an extended period. We look forward to making them more available.
Makes sense. Thank you. How are you thinking about the potential for further M&A from here? You noted that there was a bit of a focus on biz dev within wealth management. Any color there and perhaps on some of the bid-ask spread with some of the opportunities?
Oh, in our wealth management business, again, that's another area where we do think there are opportunities for us, and that is at one of our managers. We have focused, and the team there has had plans in terms of opportunities to expand their client base, and we specifically referenced the business development side of that. So, we look at that as another area of opportunity with the value proposition that we have there.
Yeah, I would just add that that's more on the organic side.
Yeah.
Rather than the inorganic. Those business development resources that we alluded to in the prepared commentary were really expanding professionals who are going out to expand the client base organically.
Got it. Makes sense. Any commentary on the inorganic side, perhaps business-wide?
Yeah, on the inorganic side, as we have always said, we do think it is important that we have a strategy on the organic side to continue to grow the business. On the inorganic side, we always will consider or evaluate opportunities where we think that they can be additive to the creation of long-term value. Generally, we have spoken to things that would either add a differentiated capability that is complementary to what we have or expand our distribution footprint. But no specifics on any other areas at this point.
Got it. Thank you.
Thank you.
Your next question comes from the line of Ben Budish of Barclays. Your line is open.
Hi, good morning. This is Isabella on for Ben. Thank you for taking my question. Maybe just start on the comp ratio. Came in slightly below the 54% guide alongside the lower incentive fees. Can you quantify those fees for us for the quarter? Remind us what drives those fees, and then also, how should we think about those going into Q4? Thanks.
Sure. Good morning. I think there are two pieces there. You were targeting the employment expense ratio and then maybe the performance fees on the investment management fee side on the top line. We did talk about ending assets and how they ended the quarter compared to the average. Certainly, that factored into our go-forward employment guide. I think of ticking up to 54%-56%, just given the impact on average versus ending, as well as the meaningful redemption that we alluded to. We factored all of that into the fourth quarter guide. I think performance fees will vary. We have performance fees in several parts of the portfolio, and I think it will vary.
Looking at the fee rate to think about the fourth quarter, I think the level of 43 basis points that we alluded to is appropriate going forward, and we'll call out performance fees as they arrive to continue to provide transparency for modeling.
Great. Thank you. In terms of flows, private markets saw better flow trends this quarter. Can you give us an update on what is driving that improvement, where you are seeing the strongest demand, and how that pipeline is developing from here?
Yeah. I think you are referring to the alternatives category, which has been an area of growth. That does include some private markets, but it also includes our listed. Our definition of alternatives includes the global listed real estate, which, as a reminder, last quarter we had a very huge listing. I think the composition of that includes managed futures, some private markets, but a lot of it is global listed real estate. We see all of those, and even on the managed futures side, that has been an area where, with the performance and certain changes in investor preference, we have seen growth there as well. Mike, any other color you would add?
No, I think that is right. I think specific to the tender offer funds, they were positive in the quarter, and that has been a continued trend that we have seen, and we will continue to, again, provide that disclosure accordingly.
Great. Thank you.
Thank you.
If you would like to ask a question, please press star one on your telephone keypad to join the queue. Your next question comes from the line of Crispin Love of Piper Sandler. Your line is open.
Hey, good morning. This is Ben Graham in for Crispin Love. Thanks so much for taking my question. On the topic of alternatives, with it now representing around 14% of total AUM, as you mentioned, I am just wondering how you sort of view the long-term target for that segment, and if the goal is to maybe eventually reach a specific percentage of total AUM, or is it more about providing a sort of menu of options for your wealth management distribution partners? Thanks.
Yeah. No, thank you. Great question. A lot of it is along the lines of the latter part of what you said, right? As we continue to say, our strategy is to try to provide the building blocks of a well-diversified portfolio. We believe that a well-diversified portfolio, whether it be for institutional or retail clientele, does need to include those strategies that have less correlation to long-only traditionals, which is really kind of like the alt bucket. Again, the alt bucket including things that are public but less correlated to some of the broader indices, as well as that which is private. Our goal is to provide differentiated capabilities and have clients increase their allocation.
I think there is a general view that the allocation currently to those types of strategies by individual investors is less than, I think, the targets that a lot of firms, brokerage firms, and financial advisors give to their clients. So we are there to try to provide some of the offerings to help them get to that level. We do want that to be. We like our business to be diversified. So, currently at about 14-ish percent or whatever of our AUM, I do think we expect that. We would like that to be a slightly higher percentage of our overall book.
Awesome. Thank you so much. I appreciate the color there. Then just briefly on capital return. I know you mentioned increasing the dividend this quarter, but between that and buybacks and acquisitions, with where the stock is today, I am just wondering where you are most focused on the capital return side. I know there is, of course, seasonality in results, but just as you look out broadly on maybe an intermediate focus, if that will remain on the dividend or go elsewhere.
Yeah. No, good question. One of the reasons we always try to highlight that we maintain flexibility to balance between investing in the business, paying down debt, or repurchasing is, as you point out, in any specific period, there may be things that are either of higher or lower priorities, right? So, we evaluate it every quarter. As we indicated in our remarks, we do have meaningful liquidity available to us in terms of our cash, our investments, as well as our untapped facility. So, we will be doing what we normally do, which is evaluating that as well as our future obligations to determine the highest and best use of capital.
Awesome. Thank you so much. I will step back.
Thank you very much.
This concludes our question and answer session. I would now like to turn the conference back over to Mr. Aylward.
Great. I want to thank everyone today for joining us, and we certainly encourage you to reach out if you have any other additional questions. Thank you so much.
That concludes today's call. Thank you for participating. You may now disconnect.